The race to the bottom: Imps, Ponzis, and negative yields

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In Robert Louis Stevenson’s short story “The Bottle Imp” a man is sold a demonic bottle which grants the owner the power to gain all he desires. There are just two catches; first, if he should die with the bottle still in his possession he will be condemned to eternal torment, and second, he can only sell the bottle for a price lower than that at which he bought it.

It adds to a large number of bonds with negative yields in the secondary market already in existence; there are negative yields out to maturities of at least 5 years in France, Germany, the Netherlands and Switzerland.

Not many of the holders of these bonds will have bought the bonds at negative yields, nor will all the buyers of the bonds today necessarily consider themselves to be motivated by price.

However, it is the case that when buying these bonds today, you are guaranteed a negative nominal return – unless that is, you can sell the bond on to someone else who is happy to accept an even more negative return in the future.

In a Ponzi scheme you are similarly reliant on not being left ‘holding the baby.’ The only difference is that in a Ponzi scheme the next investor does not know they are in store for a loss. Making money from investing in negative yielding government bonds is even more risky; as the yields reach ever more negative levels the extent of the loss is there for everyone to see.

In Stevenson’s story the hero manages to escape his fate by finding the greater fool, but it is a stressful ride. Finding investors willing to pay even more than you for the privilege of lending to a government should be equally stressful, and certainly not a property you’d want to associate with a safety asset.

The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. Past performance is not a guide to future performance.

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Welcome to the M&G Multi Asset Team’s Allocation blog, previously known as the Episode blog. We have changed the name of our blog to resonate better with our readers in Europe, however, the content and purpose of the blog has not changed. The Allocation blog continues to aim to provide unique market perspectives from our dedicated team of experienced asset allocators.